As investors search for yield amid historically tight credit spreads, questions may arise about how they might improve the risk-return profile of a traditionally diversified portfolio. Fortunately for investors, access to an asset class characterised  by higher yields and attractive risk-adjusted return potential is expanding beyond its institutional roots at an opportune time.

Collateralized loan obligations, or CLOs, generally offer higher yields than comparably rated corporate bonds, such as those in the Global Aggregate Index. While CLO tranches are designed to offer various levels of risk and return, the highest-quality CLO tranches are notable for their consistent ability to deliver attractive income with little risk.

“In a world of elevated rates and persistent uncertainty, AAA CLOs offer a rare combination of high-quality credit, floating-rate coupons, and structural resilience,” says PGIM’s Edwin Wilches. “For investors seeking to enhance yield with minimal credit risk, AAA CLOs offer a compelling alternative to traditional fixed income holdings.”

Wilches should know. He helps oversee PGIM’s $75 billion CLO platform as part of his responsibilities as co-head of PGIM’s $145 billion securitized products team. 

Managers Make a Difference

The $1.4 trillion-plus CLO market is poised for growth as new publicly traded securities increase access. That means CLOs will be new to many investors, accentuating the importance of experience, resources and performance attributes when selecting managers. PGIM ranks among the world’s top 10 CLO managers and top 10 CLO issuers⁴. 

Backed by extensive institutional experience, PGIM enjoys resources and relationships that position it to play a leading role in the expansion of an asset class known for complexity and wide performance dispersion among managers. “PGIM offers an edge in sourcing, structuring, and secondary market execution,” says Wilches. “We’re able to negotiate better terms, including wider spreads, stronger protections, and ESG criteria, to deliver structural resilience and high-quality income.” 

The “Risk-Remote” AAA Opportunity

Senior secured loans represent the primary collateral in CLOs. The loans are pooled into a special purpose vehicle, which issues  tranches of varying credit quality. Though carrying the lowest credit risk, the AAA tranche enjoys added protection from the CLO structure, which distributes payments from the underlying loan pool to the highest-quality tranches first. That means the AAA tranche is last in line in terms of absorbing losses. 

There have been no defaults or capital losses in the AAA tranches over more than three decades of market history. Wilches describes high-quality CLOs as “very credit-risk remote.”

Enhanced Diversification

CLOs are backed by actively managed, diversified pools of senior secured loans, resulting in low correlations with traditional fixed-income sectors and equities. Offering uniquely robust cashflow, incorporating AAA CLOs can meaningfully improve portfolio risk-adjusted returns and overall quality.

To Wilches, who considers AAA CLOs to be among “the most attractive and cheapest assets across global fixed income markets,” the timing couldn’t be better. “With rate cuts on the horizon, investors are rethinking their cash allocation. Senior CLOs offer that rare combination of liquidity and resilience without sacrificing yield,” he explains.